6 Billion Ways: When did we become obsessed with monetary policy?

I’m at the “Six Billon Ways” conference this weekend, which is organised by the main NGOs campaigning for global justice – this is my thoughts on the first discussion – and a broader frustration with some of the discussion this movement is having about the financial crisis…

I only caught the end of the 6 Billion Ways workshop “the history of money”. But I have to admit, it wound me up a little, for two reasons. The first is that it talked about fractional reserve banking. As Ann Pettifor puts it, “there is no such thing as fractional reserve banking”. If banks called in all of their loans, then they could pay back all of their debts. It is true that, because we give the money we borrow from banks back to those banks, they can lend those pounds out again. But that doesn’t mean money – deposits – is just created out of thin air.

But that wasn’t my main objection. My main disagreement with the analysis given in the conclusion of this workshop was that it blamed the credit crunch on the way that the money supply was removed from the gold standard in the 1970s. Or, more specifically, it blames the way that the economy became overly financialised – that too much of our wealth was focussed in derivatives and other financial products – on specific policies about how we organise our money supply.

And I think this is wrong for 2 reasons. First, I think it’s wrong because it, for me, it misunderstands what went wrong. David Harvie’s analysis is much more compelling for me. Harvie argues that the credit crunch happened because of a broader crisis of capitalism – specifically, he tells us that capitalism is supposed to work on the theory that the surplus capital – extra wealth – created by our work is then re-invested in socially useful things: new inventions, new companies, new ideas. But this is hard. Building things or inventing things are tricky. It is much easier – particularly in the short term – to make money out of money. And so our surplus capital, controlled by the mega-rich, was invested not in things which are useful for society, but in making money out of money – in gambling on derivative markets.

Or look at what’s happened in people’s lives. In the USA, real wages haven’t gone up since the 1970s. In the UK, they have stagnated as the wealth in our economy has increasingly been distributed through shares (disproportionately to the already wealthy) and decreasingly through wages. As most people’s wages stagnated, but the mega-rich got much richer, pressure to allow credit increased – the iron fist that was keeping everyone poor was cushioned with a velvet glove of credit.

Ultimately what went wrong was not that some men in sharp suits somewhere made a tactical mistake when deciding how to organise our money supply. What went wrong was what has always gone wrong in the economy: a small group of very powerful people managed to secure an economic system which made them wealthier in the short term.

And this leads to my second objection. If we go around talking to people about a specific technocratic failure in the way some clever men organised the money supply, then we misunderstand what political economy is about. It is easy to believe that the way we organise our society is based on evidence and argument. But the truth is that society is organised around the competing interests of different groups in society. And so what we need to do is not try to persuade a few clever men to change our money supply system, but organise our power to force control of the economy from an elite. And that, surely, is a much more compelling, and a much more empowering message.

So, please, let’s stop talking about the money supply – it does need reform, but it isn’t why our economy was destroyed. And let’s start talking about what really went wrong with our economy – we handed it to an elite of bankers, and hoped that they would create real wealth for us all. And we failed to understand tht it is we, all of us, who create wealth, and it is we, all of us, who should contol that wealth.

Related Posts

8 Comments Already

Daniel Key-March 6th, 2011 at 11:32 pmnone
Comment author #12663 on 6 Billion Ways: When did we become obsessed with monetary policy? by Bright Green

I think it’s pretty harsh to pass judgement on a talk when you only caught the end of it. The speaker had a great format for this workshop, with loads of interaction with the audience and a chance to hear a diverse number of opinions about money. He was also promoting the Brixton Pound, an example of a local exchange trading system initiated by Transition Town Brixton.
I think it’s great that we are talking about money, as so many people just don’t understand the issue and resort to lazy labelling of the bankers – yes of course this is a bankers crisis and they should pay for it but it’s not as simple as that, the fact that our money system has mutated to floating currencies, financial derivatives, credit default swaps, NINJA loans and other crap is just insane and needs to be explained so that we can find alternatives. I recommend the New Economics Foundation publications to learn more.

They are immune from wider economics! But will argue at length….any economic analysis that does not give a nod to Marx and Ostrom probably doesn’t quite get to the roots of linked economic, social, economic crisis on our planet, in my opinion.

I feel there are two main problems with your thesis here, the first is what I feel was a misunderstanding of the connotations of what Ann Pettifor meant when she said that “fractional reserve banking doesn’t exist”, and the second is that you misunderstand the focus of money reformers. We do not feel that speculation was insignificant in causing the financial crisis, or that everything can be tied back to what we refer to as fractional reserve banking, but we do feel that changing the setup of the monetary system can help to prevent bubbles and socialised losses, can help remove the moral hazard that causes these problems to begin with and to remove the burden of debt on the UK public, and can go some way towards preventing the alignment of business cycles that eventually result in credit booms and squeezes of disastrous consequence.

Fractional reserve banking traditionally meant that a bank had to keep back 10% of the money they had out on loan as a liquidity buffer, and that the money they lent out would then bounce back into another bank account at the same bank sooner or later, and continue until the 10% kept back reduced into nothing. This is the “money multiplier” effect, and it is what many money reformers and popular online videos such as “Money as Debt” get wrong. Fractional reserve banking, in this sense, does not exist.

The setup we have now works differently, a bank must now be “adequately capitalised” (to a far lower degree than before) with a dual monetary system of bank reserves and credit money. Securitisation allowed banks to effectively sidestep these regulations, selling on their debt to free up capital and use it as a basis to make more loans. Credit can, in effect, be extended ad infinitum. Payments are made between banks in “base money”, if you transfer me £10, the credit balances of our bank accounts will increase and decrease respectively, but £10 of actual base money will be logged as a transfer between our banks. As the banking system can rely on £10 transferring the other way sooner or later, trillions of pounds worth of credit can be logged with a much smaller supply of base money. The LIBOR market sees to it that banks never run out of base money to make payments with if everything does not clear on one particular day, and open market operations from central banks expand the size of the base money supply if necessary. Banks can create as much credit, which is as good to the public as real money, as they want. This has the effect of placing us within a money supply based entirely on debt, a money supply that must be “rented” from a banking system given a special privilege to operate in this way.

This might sound like a good thing on the face of it, but in reality there are costs associated with this. Opportunity costs of allowing such an enormous privilege to one sector of the economy to do this and (only recently!) expecting only £2.5 billion back in levies, and a whole host of other associated costs to the rest of society by allowing house prices to appreciate so significantly as a result of unstrained credit creation and through the money supply coming into existence as debt.

The monetary system had traditionally been set up so that banks could extend more credit than they held back to cover losses, now it is set up so that banks can extend as much credit as they possibly can, and take none of the fallout when they are irresponsible. In this way “fractional reserve banking” does not exist, the situation is far, far worse for the public who are now completely liable for all bank losses.

If you need some confirmation that in fact banks do “create” deposits, here are a few quotes from MPC members and Bank of England literature to confirm this.

“The money-creating sector in the United Kingdom consists of resident banks (including the Bank of England) and building societies” – Bank of England Quarterly Bulletin Q3 2007

I hope this clears that one up. The confusion arises because some people say that banks create “credit” and some say they create “money”. The difference should not be, but is, purely semantic. Now all banks have deposit insurance, if they become insolvent and cannot pay out deposits, the government picks up the bill. This means that the credit in your bank account is as good as cash, in any sense, as money, but you pay for the risk as it is added on to the national debt, and you don’t even get cheap credit in return while the banks pay out astronomically high bonuses, no longer fearful that they actually can make a loss.

Banks are inherently unstable, the deposit insurance the government provides was undoubtedly necessary at the time of its inception to avoid major panic and bank runs, but an incredibly dangerous moral hazard has arisen as a result. Now it is much cheaper for the government to bail out the banks than it is to let them fail and pay out deposit insurance. Letting RBS fail would have cost us about £650bn in deposit insurance, bailing them out with a capital injection cost us £45 billion, this is clearly very disturbing, sending a message to banks that we will never let them fail, ever.

So we have a series of problems that absolutely must be fixed.

Banks have a special privilege to create almost infinite credit and bear none of the risks of doing so, while collecting all of the profit.

97% of the money supply that is used to make payments is created through making loans, placing an enormous burden of debt upon the public who must effectively “rent” the entire money supply from the banking sector.

The public have almost no say as to where their money goes, the decision resting with bank staff who have tended to invest it in areas that do not benefit the customers.

The nature of the money supply, as being created with a matching level of debt, means that the economy is reliant upon others continually taking out new loans to maintain the size of the money supply and enable those already indebted to pay off their debts. This has the effect of aligning business cycles, so that during a credit boom where lots of new businesses start up, there is lots of money sloshing around to pay off debts with and everything is happy and it is a good environment to start a business within. Towards the end of the business cycle, the money supply begins to decrease in size and it becomes harder and harder to find money to pay off debts with, and a recession is triggered. This alignment of business cycles affecting the size of the money supply is so crucial for an economy where the total level of debt is equal to the size of the money supply, and is undesirable, as it tends to cause recessions.

These are problems that need to be fixed, the proposals of Irving Fisher in 100% money designed to fix them have been updated by Positive Money, the New Economics Foundation, and Professor Richard Werner, and we are currently testing them as much as possible in order to promote them as a different way forward.

Peter – as you say, banks (generally) borrow short to lend long. That’s how they create liquidity. Some people like to portray that as “creating money”. Whatever. The thing is, someone has to borrow short to lend long, because there’s a surplus of money that wants to lend short, and a shortage of money available to borrow long; and banks are the ones who do it. That’s pretty much what a bank is, by definition.

And they can make a profit on that, because the yield curve rises: interest rates tend to be higher on longer-term loans than on shorter-term loans. And no bank can lend more than it has borrowed or had invested in it, despite the febrile nightmares of the money-creation fringe.

I agree with Adam Ramsay: all this pointless fretting about money creation does detract from the real economic arguments. On the other hand, there’s virtually no knowledge or expertise in the monetary reform crowd, so there’s very little going to waste.

I’m a bit baffled as to why you see a difference between the organisation of the money supply and the organisation of the economy by an elite – the two are inextricably linked. If you control the money supply and the creation of credit, you have a very strong position in directing an economy – hence why the UK economy became based around an asset bubble in property rather than manufacturing (75% vs 3% of bank lending in recent years).

As far as my interest in monetary reform goes, its based around an understanding that fits completely with a political economy vision as you outlined following David Harvey (isn’t it spelt that way, not “harvie”?)

I’m also still struggling with your problem with fractional reserve banking. The point that many monetary reformists make is that banks create money/influence the money supply through extending credit as much as they like, and then collecting deposits/reserves from that. What we call this system is inconsequential, saying “fractional reserve banking doesn’t exist” is only useful in a semantic sense. I don’t think Ann Pettifor completely rejects an understanding of banks effecting the money supply (at the same time directing the economy as a result).

It’s disengenuous to say “If banks called in all of their loans, then they could pay back all of their debts”. While that is true in a sense, the whole problem with banking is that of “borrowing short and lending long” – deposits are largely ‘demand deposits’ (ie, can be called in at any time), while lending is long term.

This is pretty basic – it’s the immediate reason for Northern Rock’s nationalisation. In theory, the rock could have called in all its loans so it wouldn’t matter than it had a run on it’s deposits. But those loans were mostly mortgages – and all the mortgagors would have defaulted if they’d been asked to stump up the full amount immediately.

So in practical terms, banks do rely on the assumption that only 11% of deposits will be withdrawn on any particular day.

It’s not fractional reserve banking as you (and Ann Pettifor?) might like to define it…. but it certainly has enough similarities not to dismiss monetary reform arguments.

I don’t think monetary reformers see this as a technocratic issue either – it was an eminently political decision to hand over moneycreationviacredit to banks.

I really think you should engage with what positive money are doing – I think they’re managing to bring this together very well: http://www.positivemoney.org.uk/